RBI Clamps Down On Variable Pay Of Top Management At Private Banks

The Reserve Bank of India has tightened rules for compensation packages offered to top management at private lenders and introduced mandatory rules to claw back rewards should a lender falter.

The RBI's final rules, which followed a draft set of guidelines put out for consultations in February, come against the backdrop of weak asset quality performance of a number of private sector lenders over the last few years. The rules, the regulator said, follow the Principles for Sound Compensation Practices issued by the Financial Stability Board in April 2009. The RBI has implemented part of these rules in previous years and is now taking them forward.

The rules will apply to chief executive officers, wholetime directors and material risk takers at private banks, small finance banks and domestic executives of foreign banks.

Variable Pay: What & How Much

The significant change made in the new rules pertains to the variable pay offered to top management at banks.

As per the new rules:

• At least 50 percent of the total compensation should be variable and paid on the basis of individual, business-unit and firm-wide measures that adequately measure performance. At higher levels of responsibility, the proportion of variable pay should be higher, the RBI said.
• Total variable pay shall be limited to a maximum of 300 percent of the fixed pay.
• If variable pay is up to 200 percent of the fixed pay, a minimum of 50 percent of the variable pay should be via non-cash instruments.
• If variable pay is above 200 percent, a minimum of 67 percent of the variable pay should be via non-cash instruments.
• Share-linked instruments shall be included as a component of variable pay.
• Guaranteed bonus should not be part of the compensation package, except in cases such as joining bonus.

The RBI has also mandated provisions to extend the period over which variable pay should be paid out. The deferral period should be a minimum of three years and should be applicable to both the cash and non-cash components of the variable pay, the regulator said.

Malus & Clawback

The RBI has asked all banks to put in place provisions for clawback of compensation in cases where a lender's performance deteriorates. While some banks, such as ICICI Bank and Yes Bank, have used clawback clauses, there are no standardised rules across the industry for this.

The RBI now says:

• Deferred compensation should be subject to malus/clawback arrangements in the event of subdued or negative financial performance of the bank and/or the relevant line of business in any year.
• Banks shall identify a representative set of situations which require them to invoke the malus and clawback clauses.
• Clawbacks may be applicable on entire variable pay.

Importantly, the RBI has specified that a clawback clause will kick in if there is a divergence in bad loan classification of more than 15 percent, which requires a public disclosure.

Compensation For Risk-Control Staff

The regulator has also set aside different guidelines for officials who are intended to control risk and ensure compliance at banks. “Effective independence and appropriate authority of such staff are necessary to preserve the integrity of financial and risk management's influence on incentive compensation,” the regulator says.

Under the new rules:

• Risk control and compliance staff should be compensated in a manner that is independent of the business areas they oversee and commensurate with their key role in the bank.
• The mix of fixed and variable compensation for control function personnel should be weighted in favour of fixed compensation.
• However, a reasonable proportion of compensation has to be in the form of variable pay, so that exercising the options of malus and/or clawback, when warranted, is not rendered infructuous.